Gareth Davis, chief executive of the group, said already 60 per cent of UK demand for hand-rolling tobacco was supplied through re-exports from the Continent. Sales by Imperial, recently demerged as an independent company from the Hanson conglomerate, along with market leaders Gallaher to European countries like Belgium were immediately being turned round and returned to the UK because of the big tax differential involved, he said. He claimed the third-largest brand in the UK was being sold illegally as the Dutch owners did not own the brand name.

Mr Davis warned that one of the more serious effects of the decision by the Chancellor, Kenneth Clarke, to put another 15p duty on a packet of cigarettes would be to give further encouragement to this trade. "Currently smuggling, principally hand-rolling tobacco, is costing the Exchequer pounds 560m a year," he said.

Meanwhile, he forecast that the home market for cigarettes would face another 2 to 2.5 per cent decline, similar to last year, as a result of the duty increases and prompt smokers to "down trade" to cheaper brands.

Despite the adverse background, Imperial reported a 5.2 per cent increase in pre-tax profits to pounds 366m in the year to September, its first as an independent entity since being acquired by Hanson 10 years ago.

The profits, which were struck on sales raised 7 per cent to pounds 3.82bn, were described by Mr Davis as "a good achievement in the context of the total market". The shares have been pulled in different directions by bid speculation on the one hand and a lawsuit brought by lung cancer sufferers on the other since they floated at around 375p in October. Yesterday, they gained 4.5p to 373.5p, although the company was silent on any bid approaches.

Imperial said market share rose from 37.1 to 38.2 per cent in the period, just behind Gallaher on around 39 per cent. Mr Davis said it was the sixth successive year that they had grown profits and market share.

The group now claims three of Britain's top five selling brands in Lambert & Butler, Regal and Superkings. Lambert & Butler had particularly benefited from the move down market by smokers, Mr Davis said, and now accounted for over 11 per cent of the market.

Profits from overseas, an area earmarked for expansion, rose 55 per cent to pounds 70m and now represented 19 per cent of the total, just 5 percentage points below the company's target level for the end of the decade. Volumes grew in both Europe and the Far East.

Mr Davis shrugged off the likely effects of the impending flotation of Gallaher and reiterated his confidence that the company had good defences against the ground-breaking legal action brought by 12 cancer sufferers last month.

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